Diversification – Investing (Photo credit: 401(K) 2013)
The 7Twelve Portfolio is an excellent concept for financial planners and novice investors alike. The book is very well written and easy to comprehend as Dr. Israelsen keeps the concepts simple and analogies easy to follow. The crux of the book is regarding diversification and Dr. Israelsen uses the analogy for making salsa as a reference. For example, you don’t have salsa of you just have diced tomatoes and it really doesn’t improve if you simply add some onions and salt. It improves a little bit, but still isn’t salsa.
The same is true for diversification. You’re not diversified if you own one stock or bond in your portfolio and have all of your holdings in that one asset. The benefits of diversification begin when you start adding additional ingredients to the mix. This starts to lower risk and help maximize return. This is a concept us nerdy planners call correlation. The less assets are correlated the better. That means when one asset class falls a different asset class may rise or even stay the same.
With enough ingredients in our salsa of investments we get a portfolio that’s well diversified and less susceptible to extreme gyrations in the market. It also provides a portfolio that generates better returns than one would think simply because we got the ingredient mix correct.
Think of it this way: you absolutely love dessert. But too much of a good thing isn’t always the best idea, right? If you just ate dessert all the time, your blood sugar would spike and then you’d crash later in the day. What you want is a balanced meal that keeps your energy relatively even throughout the day. With investing, if you only have one or two investments, you’ll reach extreme highs and then you may crash later as well. Having the right mix of assets keeps your portfolio balanced and better prepared to handle “market indigestion”.
Overall if you’re looking for a good book that reinforces the diversification discussion (and you like salsa) the 7Twelve Portfolio is a good, short read that will give some valued insight on proper diversification and asset allocation.
